Earlier this month, I wrote about how you should go about coming up with a good business idea. Let's say you followed my advice, and you decided on an idea that was so good that you were able to convince potential investors to listen to your pitch for money.
Now you've got a problem -- you have to figure out how much you will need before you have a product you can start selling to bring money in the door the old fashioned way -- by profiting each time you convince a customer to buy your product.
The amount of money you need to raise depends on many factors. You'll need more money for rent if you're in Palo Alto than you will in Sioux City. If you hire top-notch engineers, you'll either have to pay them a high salary -- or make up for a lower salary by offering them a stake in the company.
With that in mind, here are five steps to calculating how much money you need to raise to get your startup off the ground.
1. Choose your business model
Most startups today need money to build a series of prototypes of an app that -- after getting feedback from a handful of potential customers -- is such a great solution to their problem that they'll write you a check to buy it. There are many other business models you could choose -- you could build a physical product and sell it or you could give away a product to consumers and sell advertising to businesses that want to reach them.
Once you know your business model, it's much easier to figure out your startup costs.
2. Analyze the startup costs of other companies in the same business
Once you decide on your business model, it's challenging to figure out just how much money you'll need to get off the ground. One way to approach this problem is to make a list of companies in your industry and ask their founders what their startup costs were, whether their initial estimates were accurate (or not), and what advice they'd give you on how to come up with a realistic number.
3. Decide whether you could get started with the same or lower startup costs
After studying the startup costs of other companies in your industry, you should consider whether you would want to follow in their footsteps -- or would be better off asking for more or less money to get started. Regardless of what you decide, the chances are good that if you study the startup costs of other companies in your industry and think about whether they'd work for you, you will be in a much better position to answer the questions that potential investors will ask you about why you need that amount of money.
4. List all the categories of startup costs you'll incur
Now it's time to start putting your startup cost numbers together. First, think about the categories of costs you'll need to cover before you start selling your product. These will vary depending on the business model you picked. If you're making a physical product, you'll probably need money for inventory before you begin selling and if you build the product yourself, you'll need money for a factory, machines, and workers. If you're building an app, you will need money to hire coders and marketing people to find potential customers, listen to them carefully to understand their unmet needs, and get feedback from them on the prototypes you're developing to meet those needs. You'll need money for their salaries, their office space, and the computers they use to develop the apps and communicate with each other.
5. Make a spreadsheet to add up all your startup costs
The final step is to create a spreadsheet that lists all the categories of startup costs, estimates how much you'll need in each category, and adds them up to give you your total. One thing I think is worth doing is to add a contingency amount -- say 10% of the total -- just in case something unexpected happens. That 10% may be too low as I have heard many startup experts quip that you should take whatever amount you estimated and double it.
If you do a spreadsheet, it is worthwhile sending it to people who are experts in your industry to get their feedback.
Once you've updated the spreadsheet based on their feedback, you should have a solid answer when investors ask you how much you need.